Where’s Pest Control?

If the subprime mortgage crisis is the cockroach that darts from under the kitchen sink and scares you half to death, what are the chances it's the only one there? Unlikely, according to the "cockroach theory" of credit, which holds that debt woes, like most vermin, travel in hordes. The theory's origins are obscure, but the logic behind it is clear: the same loose-lending, slipshod risk analysis and blinkered optimism that fueled America's housing bubble has most likely bred a lot of other bad stuff, too.

Investors battered in last week's global stock sell-off are beginning to understand that. Indeed, much of last week's pessimism stemmed from "fear that the credit crunch … appears to have ramifications on corporate and consumer loans," says Tony Phoo, a Taiwan-based economist for Standard Chartered Bank. The big unanswered question is the stuff of childhood nightmares: just what is that thing lurking under the bed? Broom and spray can at the ready, NEWSWEEK peeked into various financial dark spaces, hidden corners and cupboards. Here's what we found:

Subprime, the sequel: This one first lunged in mid-2007. But nobody has yet figured out how many appendages this creature has or where the egg sacks are hidden—much less squashed it with a shoe. To date, various banks, insurance companies and hedge funds around the world have declared $130 billion in subprime-related losses. But last week Moody's Economy.com estimated that less than half of current losses have been disclosed. The Japan Research Institute forecast eventual worldwide losses at $463 billion. Loss declarations have been slow, in part, because the financial products involved are too complex to value. And one important variable is falling U.S. home prices.

AmEx, Visa or MasterCard? Take your pick, but the tab is now $940 billion. That's roughly the total revolving balance on all U.S. credit cards today. And according to credit-rating agency Fitch, it rose by 7.4 percent in December from a year earlier. Balances have increased over the past three months at their fastest rate since the 2001 recession. The good news: default rates are still below historical averages. The bad news: they're rising. Goldman Sachs predicts that credit-card losses could ultimately reach $99 billion.

Homes cum ATMs: America's consumption binge was a housing thing. The real-estate boom allowed homeowners to refinance periodically to take vacations, meet tuitions or affix kitchens with Viking ranges. When housing prices fell, using the homestead as an ATM got tougher —unless homeowners had home-equity lines of credit they had yet to fully tap. Those who did are now dipping more frequently, but delinquency rates are rising. Banks like Citigroup and Wells Fargo cited the rising numbers as one reason behind their massive fourth-quarter write-downs.

Cars and college: The kids of America's baby boomers have swelled national roadways and lecture halls. College admissions are up more than 30 percent since 1990, according to U.S. Census data. But credit analysts fear that slower job creation will trigger a spike in defaults for student and auto loans. Trouble is brewing on both fronts. Signs are beginning to emerge of problems in the auto-loan industry, with big lenders like GMAC seeing rises in defaults and late payments. Student-loan originator Sallie Mae, which holds 40 percent of the $85 billion market, lost $1.6 billion last quarter. In the big scheme of things, both categories are more nettlesome than lethal. But they're worth watching nonetheless, particularly if U.S. unemployment surges.

Monoline madness: Monoline insurers are like traditional life- or homeowner-insurance firms, but their only line of business is writing policies for bonds, which guarantee debt worth a staggering $2.4 trillion worldwide. Many of these policies guarantee interest and principal on mortgage-backed debt, making the whole industry deeply vulnerable to the subprime threat. When these insurance providers falter, there's a scary multiplier effect. If their policies prove worthless, the banks, hedge funds and other institutions that hold them would all be forced to reassess the risk of the underlying bonds and make appropriate provisions. For instance, on Jan. 18, Fitch cut the AAA rating on Ambac, the world's second largest monoline, to AA, on concerns over its exposure to subprime. That reportedly forced Fitch to cut the ratings of thousands of other bonds to match the underlying rating. Some analysts argue that last week's surprise Fed rate cut was aimed at bolstering these insurers. And shares in Ambac and its giant rival MBIA Inc. surged due to lower interest rates and news of a possible state bailout of a beast that was once largely obscure, but is now potentially terrifying.

With Jonathan Adams in Taipei

© 2008